Great post from Dana Boyd about the new digital gifts that Facebook released recently. After ranting randomly about rampant commercialism, she gets to the good stuff; analyzing gift giving dynamics (self worth, scarcity, levels of value, reciprocity, importance of timing) and how Facebook’s release measures up to that (spoiler – not very well). Well worth reading.

I’ve previously posted on the importance of distribution during the initial phase of a startups life. To be more accurate, I think that distribution is the most important factor for a consumer facing company competing in a new category.

However, I think that this is just the first act of a three act play, with a different factor being critical to success in each act.

ACT ONE: DISTRIBUTION

To summarize the earlier post; early in a category’s lifecycle, users don’t recognize that they have a particular need/problem. They don’t recognize that a category exists and so there is no demand pull. If even your own mother doesn’t know what it is you do; ESPECIALLY if your own mother doesn’t know what it is you do, then you likely face this problem!

Having the best product is neither necessary nor sufficient. Having a decent product is good enough.

You need to get to users as they won’t get to you. Hence the importance of distribution. Read the original post for flavors of distribution and how to get them, plus examples.

ACT TWO: PRODUCT

Over time, categories become established in the minds of consumers. In the case of online travel agencies it took about 3-5 years. In the case of user generated video, it took only 12-18 months. Consumers start to understand who the competitors are in an industry. If switching costs are low (as they are in both online travel agencies and user generated video), users often sample the offerings from multiple competitors. At this stage, assuming that you have done enough to get into the consideration set, product and user experience matters a lot. Distribution has become the ante, and the companies that win will win on the best product.

Having the best product means much more than having the most checks in a feature comparison matrix. It goes far beyond the technology. It can mean having the best prices, the best selection/range, the best customer service or the best community. In the early days of online travel Travelocity won on distribution through its deals with AOL and Yahoo! But once the category became established in people’s minds, Expedia slowly took market share from Travelocity on the back of a better overall user experience, one important factor being better pricing (mostly hotel pricing). [Update: Note comments below from Rich Barton, founding CEO of Expedia, on his view of why Expedia overtook Travelocity.]

Similarly, many user generated video sites claim better features than Youtube, yet Youtube never lost its lead because it had the biggest range of content (and the biggest audience for people looking to upload videos). As technologists we can fall into the trap of defining “best product” too narrowly, but our customers are not technologists and they look at the whole experience.

ACT THREE: BRANDING

As a category continues to mature, it becomes harder to maintain product differentiation. There are some exceptions; when there are positive network effects an early leader like Ebay or Youtube can often hold their leads. But if the advantages built in Act Two stem from technology, process or supply advantages, these often get whittled away as competitors copy, innovate and partner to make up lost ground. At this stage of a category’s evolution, branding is the most important factor and product has become the ante once again. (Note that I distinguish here between branding and marketing. Online marketing that is more direct response (CPC or CPA) in nature is really more a form of distribution.)

Google is sometimes presented as the canonical example of the best technology winning over time. However, as I mention in the post on distribution, Google‘s traffic only really started to climb after its distribution deals with Y! and AOL. It really did pull away from the other search engines on the basis of its better product during Act Two. But today, its not at all clear that its search results are that much better than anyone elses.

When I was at AOL a couple of years ago, we used to test search relevance from multiple engines by taking the results from all the major search engines, stripping all branding and UI, and showing the lists to users who scored the quality of the search returns. The results were surprising – all the search engines were very close to each other in relevance, with variations as to who was “best” from month to month and search term to search term. Interestingly enough, when you put the branding and UI back in, the users always ratedGoogle as having the best search results.

Google‘s dominant brand is now what enables it to hold and grow its search market share. And in mature categories such as online travel, you see the big players compete purely on branding ads.

In some categories, branding never matters and we never reach Act three. If your users are unlikely to transaction with you more than once (say you sell rowing machines or curio cabinets) then your category will likely never develop beyond Act One. But if you’re in a category with repeat users, whether books, DVD rentals, online auctions, or shoes, branding matters.

CONCLUSION

Distribution, product and branding, all are critical but at different times. Making sure you focus on the right factor at the right stage in the evolution of your category can help you make sure you’re fighting the next war, not the last one.

We’re very excited to partner with Joe and Saran (the two founders) and the rest of the team. They have built an amazing user generated content site around movies, including ratings, reviews, actor pages, trivia quizes, movie compatability tests and tons of other stuff. Traffic growth has been truly viral and the site has grown from nothing a year ago to very meaningful pageviews per month from users all over the world. They’ve done a great job of applying social networking and viral best practices to engineer this growth.

As we’ve posted in the past, we’re big believers that this year social networking becomes a feature, a mechanism used to incent users to create content that will be of broad interest to many other users. We think that this is most interesting around verticals with endemic advertising opportunities. Web based advertisers still pay a premium for content related to their product (vs buying demographics or broad reach). As movie studios follow their audiences online they will be marketing more on the web, and movie related content will continue to draw premium CPMs, just as it does for Moviefone, Yahoo Movies, etc. Flixster fits right into this model.

I’ve been thinking a bit more about how consumers adopt “new” products online recently, in part because of a couple of recent posts I wrote in reaction to rumors of a Safari browser for Windows and questions on the value of widgets. What struck me is that very often, the “best” products don’t win majority market share. Many claim that Firefox is a “better browser” than IE, and I’ve lost count of the number of times I saw a pitch from a video sharing site last year that claimed to be “feature for feature, far superior to Youtube“. Yet IE and Youtube dominate their markets. And the same is true in so many categories.

Cynics might attribute this to bad luck or my favorite, user stupidity (because its always good to have contempt for your customers), but often there is a pattern at work. In a new consumer market, the winners win on distribution.

In a new consumer technology market, users don’t yet recognize that the category exists. They don’t recognize that they have a problem, so they are not going out looking for a solution. They’re not issuing RFPs, they aren’t even compiling shortlists of possible vendors. They are stumbling on solutions by accident. And that is why distribution is key in a new market.

Lets take an example; online travel. The early market share winner was Travelocity/Preview Travel. They won that early market share on the back of distribution deals with Yahoo! and AOL. In the late 90s, most internet users didn’t even realize that they could book travel online. But they were actively using portals, and through the “travel channel” on the big portals, they stumbled across the online travel agencies and started booking online.

Google is another example. It was a “better search” product when it launched in 1998, acknowledged among the Digerati. But it wasn’t until it struck its distribution deals with Yahoo! in 2000 and then AOL in 2002 that it really started to get used widely. Before users were exposed to Google through their portals, they didn’t know that better search existed.

Product is of course important. Your product can’t be actively bad. If Travelocity’s booking engine didn’t work, or if Google’s PageRank didn’t produce more relevant results at that time, then users would not have come back. But they needed distribution to be found in the first place.

Updating to 2007, the same principles apply. But whereas portals were the only path to distribution in Web 1.0, today social networks offer another way to reach internet users. But now the “discovery” process is a little different. Take embedded online video. A year ago, users didn’t understand that this was a category, they didn’t realize that they wanted to embed videos in their profile pages. But when they saw an embedded video on a friends profile, they could say “Hmm, I want one of those”, click through and get one for themselves. Now the category is established in users’ minds, and brands have been established. But earlier, “distribution” was what drove growth.

Social networks offer a different challenge than portals. Whereas you could get distribution by doing a single business development deal with a portal, on social networks, you need to convince each individual user that you’re worthy enough to keep. But as you get more penetrated into the community, a new user is more likely to run into you and try you. So scale matters and it is a virtuous circle – the more share you get the more likely a new user is to stumble on you as a provider. Going up against an “incumbent”, even with a “better” product, can get very hard. Distribution and adoption end up meaning almost the same thing. This is why Rockyou and Slide are the number one and number two fastest growing widget makers in social networks, and why VCs pay so much attention to “traction” and so little to the fact that its easy to replicate the features of these widgets.

The other web 2.0 distribution mechanism is virality. Users inviting users is the other way that a user can get exposed to a new product – solving a problem that they didn’t even know that they had. Ravi has posted on this a coupleof times so I won’t go into it again.

So the next time you build an absolute killer product in a new consumer category, don’t stop there. Unless you’ve got a plan to get new users exposed to your new product, your efforts may be for naught.

Just a short addition to my previous post. There’s been some interesting commentary on the need for both “art” and “science” to induce viral growth. The science component is comprised of a website’s ability to systematically measure all aspects of user response to viral campaigns and iteratively refine features and experience to boost propogation rates. The “art” component relates to the fact that without first creating approximate viral memes that are (a) logically consistent a site’s primary value proposition and (b) resonate with something fundamental in the audience’s psyche, its virtually impossible to jumpstart a viral growth cycle. So how does one overcome the immaculate conception problem to predictably create “good” initial viral memes? There are no hard rules as each meme must be tailored to a particular situation. However, Seth Godin’s general rules for “What makes an idea viral” presents a good starting point for basic viral meme construction. Have fun creating!

For websites with social networking or community features “going viral” or acheiving a viral coefficient greater than 1.0 represents the holy grail of traffic acquisition. What’s behind this? Going viral means that new user acquisition costs have essentially been driven to ZERO. This is a significant departure from the current state-of-the-art.

The friction of the “real world” means traditional businesses need to invest in sales and marketing to acquire and retain customers. Whether selling to enterprises or consumers and whether the sales process is direct, “high touch” or indirect via telesales, direct mail, etc, the process of bringing in customers requires money proportional to the number of new users. Internet 1.0 businesses have fared slightly better through expanded online reach but still need to invest in keyword marketing, affiliate revenue sharing and other acquisition and distribution vehicles to acquire incremental customers.

Viral marketing has emerged as a mainstream Web 2.0 phenomena whereby existing users do the work and bear the time and expense of delivering additional new users. While not univerasally applicable (yet), we think the power of viral marketing as a zero or exceptionally low cost agent for acquiring customers will expand to be applied across lots of new categories. To date we’ve observed several early variants on the model:

1) Peer to Peer Communication and Messaging: Applications like Skype or Hotmail where inherent use of the application requires a user to forward the application to other users and have them register in order to particiapte. CPM (Yahoo!Mail) and contextual (gmail) advertising and pre-paid subscription (Skype) business models have all been used to monetize these viral ecosystems.

2) Online Self Expression and Social Networking: Sites like MySpace , Flickr, and YouTube and new distributed social self expression sites or widgets like RockYou (LSVP portfolio company), Widgetbox and others enable users to invite friends to view personalized digital content. These new viewers are required to become registrants on the social networking site or can make the decision to adopt a widget in order to broadcast their own content inducing a viral growth cycle as these new users then invite additional viewers into the system. Thus far, monetization has occured primarly through online advertising although early experiments with the sale of digital goods (HotorNot) foreshadow a more transaction-based monetization model.

3) Viral email marketing: This usually takes place by way of online offers which are proposed to an initial set of consumers. Embedded in the offer is an earnable incentive or reward for successfully forwarding the identical offer to additional consumers. Campaigns can yield large numbers of responses even for offers sent to a small initial set of customers.

4) Vertical community sites. Like more horizontal social networking sites, these portals enable like-minded consumers with a particular interest to invite new users to participate in a shared affinity group. The more people who are part of the community, the faster the rate of the communities viral growth due to exponential increases in the richness of content and number of invitations sent out to new members. Viral community sites enable sharing of interests across topics ranging from finding sales leads (Jigsaw) or finding a new career (LinkedIn) to finding the trendiest new clothing styles (Stylehive – LSVP portfolio company) or getting the latest tips on new movies (Flixster – LSVP portfolio company). Today much of the monetization occurs through impression based advertising although future monetization could emerge via subscriptions, lead generation, and transactional commerce services aimed at vendors interested in accessing highly targetted channels of distribution.

We think the principals of viral marketing and viral user acquisition will be applied well beyond current initial use cases as Web 2.0 continues to evolve. It should yield some exciting new investment opportunities which we’re looking forward to hearing about and getting involved in.

We’ve seen a few of these stockpicking sites over the last little while. I think that there is a risk of a conflict of interest in touting stock picks, although if people are truly your “friends” and not just people you met on the site, this might get mitigated. Otherwise, it seems like a happy hunting ground for stock tip spammers.

The best remedy for this to my mind is to use real data. Stockpickr lets you see Warren Buffet’s actual portfolio – not much opportunity for “gaming” that system!

If there were a way to verify people’s “stock picks” – say by tying into brokerage accounts with permission to verify that they really do hold those stocks or really did make that trade, then you’d have some very interesting data. As Seth and Fred have said in the past, implicit data is much more interesting (as well as painless to collect if given permission) and truthful than explicit data.

Imagine being able to see other users’ actual accounts and trading history, and being able to tell the real trading superstars from the ones who weren’t willing to put their money where their mouth was. Would active traders be willing to pay to get real time access to the transaction flow of the top traders? People already do this for Jim Cramer. A subscription model like this would potentially generate enough money to incent top traders to open up access to their real time trading and their portfolios. They would be able to earn a nice secondary income stream and it actually HELPs their positions if others follow them. But if these active traders start gaming the syste,, people will stop following them and they run the risk of losing their own money.

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